Latin America
THERE was a marked pickup in activity in most of Latin America in 2004, with the region enjoying its strongest growth in 25-five years. This development reflects a combination of external and domestic factors. Externally, robust activity in trading partners, generally positive market sentiment toward emerging markets, and higher commodity prices have played key roles. At the same time, improved domestic policies are also contributing importantly to the turnaround.
Although high oil prices are adversely affecting some countries in the region—especially in Central America— they are benefiting oil exporters such as Colombia, Ecuador, Mexico, and Venezuela. In addition, the rise in non -fuel commodity prices has favoured exporters of metals and agricultural products such as Argentina, Brazil, Chile, and Peru.
Since 2004, a number of countries—including significantly Brazil, Chile, Mexico, Peru, and Uruguay—have all experienced ratings upgrades. In addition, many countries in Latin America have taken advantage of the supportive financing conditions to pre-fund roughly two-thirds of their net borrowing needs for 2005, thus substantially decreasing rollover risks.
Against this background, economic activity is rebounding strongly this year in Latin America, supported by a pickup in domestic demand—underpinned by easier monetary conditions in most countries and improved confidence—and the robust global expansion. The IMF Staff sees strong growth of a little over four per cent in 2005 in the region.
In 2005, economic growth throughout the region is expected to ease compared with 2004. The Latin American region is still set to post strong gains this year. Argentina is expected to show a third consecutive year of economic improvement, with 4 per cent growth predicted by IMF, versus seven per cent growth in 2004. Brazil is projected to post a 3.5 per cent gain compared to four per cent in 2004.
Chile is expected to grow by 4.7 per cent in 2005 versus 4.9 per cent in 2004. Venezuela’s recovery is forecast to taper off from the stratospheric 12.1 per cent rate seen in 2004 to 3.5 per cent in 2005. Finally, Mexico is forecast to post 3.2 per cent growth in GDP in 2005 versus four per cent for 2004. Inflation is falling in Latin America. In 2004, the consumer price index for the whole region ended up at 6.5 per cent, a noticeable improvement over the previous years. In 2005, inflation will fall further - to six per cent, according to forecasts from the International Monetary Fund. Among the top seven economies, Venezuela had the highest inflation during 2004 and would continue to do so in 2005 and 2006.
In many countries, there is still scope to secure more firmly the remarkable progress that has been made in reducing inflation. It is encouraging that central banks are continuing to strengthen their monetary policy frameworks—often in the context of inflation targeting regimes—and are being pro-active in weighing against any nascent inflation pressures, including those that may be triggered by higher oil prices.
Brazil
Brazil’s economy was set to become Latin America’s largest in 2005. Its GDP was expected to grow by 3.7 per cent in 2005. That was less than the impressive 5.2 per cent expansion in 2004, but marks good news, as it cements the continued growth after previous years of weak or no growth. In 2005 the GDP will expand by another 3.5 per cent in 2006, according to the International Monetary Fund. Inflation was set to reach 6.5 per cent, slightly less than the 6.5 per cent posted in 2004. In 2006, inflation will likely reach 4.6 per cent. Foreign direct investment in Brazil grew from $10.1 billion in 2003 to $18.2 billion in 2004, by according to estimates from the United Nations Economic Commission for Latin America and the Caribbean.
Brazil is South America’s largest exporter and importer and the second-largest in Latin America in both categories. The economy is still burdened with structural problems that undermine the prospects for long-term growth, including a convoluted tax system, barriers to foreign investment in some sectors, government management of most of the oil and electricity sector as well as a significant part of the banking system, a weak judiciary, and an overabundance of red tape.
Brazil has benefited from a growing world economy. Rising commodity prices have boosted its exports, and the low US interest rates have led to lower spreads on emerging market debt and high global liquidity. But, more important are the sustainable macroeconomic policies that Brazil has established.
A major trigger of its current strong cyclical recovery has been a substantial cut in interest rates, made possible by the credibility of its inflation-targeting regime. Also key to increasing confidence was the government’s strong commitment to fiscal discipline, notably its successful pursuit of a high primary surplus.
Brazil has grown strongly before, only to see growth falter and inflation pick up. Macroeconomic volatility has been reduced substantially, and exports have been very strong. Previous recoveries often ended because of external constraints. Strong export performance gives hope that this will not happen this time around.
Brazil’s debt has gone down, but vulnerabilities remain, though a strong fiscal policy has made the debt dynamics sustainable. Latest projections show a continuing decline in the debt-to-GDP ratio to reach the average for investment-grade emerging market economies within the next few years.
The lowering of the debt ratio would consolidate Brazil’s position in emerging markets, reduce risk spreads, allow Brazil’s debt to be ranked as investment grade, and provide room, eventually, for a counter cyclical fiscal policy to ease economic downturns. Until recently, a substantial portion of Brazil’s debt was linked to the exchange rate. The authorities have since reduced this amount significantly.
A higher proportion is, however, still linked to short-term interest rates. In the future, the government intends to further raise the fixed-rate component to make the debt less sensitive to financial market shocks. Another area of improvement is international reserves, which have been increasing substantially in recent months. Continued steps to build reserves will help to bolster confidence further.
Looking ahead, Brazil needs to follow up on its achievements in the macroeconomic arena and on the reforms conducted in the late 1990s with microeconomic reforms that will further improve efficiency. Otherwise, bottlenecks and high real interest rates may once again prevent Brazil from reaching its full potential. For this purpose, a microeconomic agenda covering five main areas—credit, taxes, conflict resolution, the business environment, and social inclusion—is being implemented.
Efforts to further improve macroeconomic conditions will continue, as illustrated by the ambitious initiative, launched in March 2005, to reduce the deficit of the social security scheme for private sector workers, and the three-year budget directive law (known as LDO) sent to Congress in April 2005. A sound macroeconomic environment will enable the government to improve the allocation of resources and push ahead with its structural reform agenda, leading to the accumulation of physical and human capital and greater social inclusion.
Chile
A strong external environment and an expansionary monetary policy have helped spur Chile’s economic growth in 2004 and in early 2005. Robust growth in the global economy, including Asia—which absorbs one-third of Chile’s total exports—has helped boost mineral export prices, particularly copper, Chile’s main export commodity. Chile has also benefited from low world interest rates. Reflecting these developments, real GDP grew by 6.1 per cent in 2004, the strongest rate of growth in seven years. Despite steady employment growth, the unemployment rate is still relatively high, at about eight per cent, as strong economic growth has encouraged more workers to return to the labour market.
In the context of a still weak economic recovery and downward pressure on domestic prices, the monetary authorities eased their policy stance in late 2003 and in early 2004. Later in the year, when it was clear the economic recovery was well under way, and the forecast inflation has returned above the centre of the target range, the central bank initiated a tightening cycle toward a neutral stance. It has raised its policy rate on seven occasions since September 2004, by a total of 175 basis points to 3.5 per cent in mid-July 2005.
External conditions faced by the Chilean economy remain broadly favourable but increases in petroleum prices could lead to a slowdown in global demand and in Chilean exports. The authorities have taken steps to protect the economy from sudden cuts in natural gas imports and to encourage a switch in electricity generation from relatively cheap natural gas to alternative sources.
In the period ahead, the economy is expected to continue its robust growth, and the GDP is projected to grow by 5.5-6 per cent in 2005. Reflecting a supportive external environment, and a still expansionary monetary policy, strong investment growth is expected to continue in 2005. Domestic consumption would also pick up, boosted by higher incomes, an increase in employment, and strong consumer lending.
Consistent with strong growth and high copper prices, the fiscal balance is projected to register a surplus of 2.3 per cent of the GDP in 2005.The current account surplus is projected to narrow to 0.5 per cent of the GDP, reflecting a higher import bill, including non oil and capital good imports.
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